Lack of buy­ers may force Trea­sury to hike in­ter­est rates

The Washington Times Weekly - - National - BY PA­TRICE HILL

The U.S. Trea­sury next month will go back to re­ly­ing on the kind­ness of strangers like never be­fore to pur­chase the nation’s bur­geon­ing debts, and tax­pay­ers may have to pay higher in­ter­est rates to at­tract enough for­eign in­vestors, an­a­lysts say.

Though a sig­nif­i­cant rise in in­ter­est rates could be toxic for a soft­en­ing U.S. econ­omy, the Fed­eral Re­serve has said it will end its pro­gram of pur­chas­ing $600 bil­lion in U.S. Trea­sury bonds as planned on June 30. The Fed is es­ti­mated to have bought about 85 per­cent of Trea­sury’s se­cu­ri­ties of­fer­ings in the past eight months.

That leaves the Trea­sury, which is slated to sell near-record amounts of new debt of about $1.4 tril­lion this year, with­out its main suitor and re­cent source of sup­port, and forces it back into the va­garies of global mar­kets. Among the coun­tries that will have to step for­ward to pre­vent a de­bil­i­tat­ing rise in in­ter­est rates are China, Ja­pan and Saudi Ara­bia, and even hos­tile na­tions such as Iran and Venezuela with petrodol­lars to in­vest, ac­cord­ing to one anal­y­sis.

The cen­tral bank launched the un­usual bond-buy­ing cam­paign last fall in an ef­fort to lower in­ter­est rates and boost the sag­ging econ­omy, and it was suc­cess­ful at draw­ing down long-term in­ter­est rates to record lows last win­ter. In par­tic­u­lar, 30-year fixed mort­gage rates fell to un­prece­dented lows near 4 per­cent and spawned a re­fi­nanc­ing wave that helped con­sumers to dis­charge debts, pur­chase homes and in­crease spend­ing.

But by the start of the year, a pickup in in­fla­tion, led by a surge in oil and other com­mod­ity prices that some econ­o­mists blamed on the Fed’s easy money poli­cies, wiped out the boon for con­sumers and home buy­ers and started to weigh on the econ­omy. With the econ­omy re­laps­ing back to tepid rates of growth around 2 per­cent, some Fed of­fi­cials ar­gue that it should con­tinue the eas­ing pro­gram, but fear that the com­mod­ity boom could turn into a se­ri­ous in­fla­tion threat makes it dif­fi­cult for the Fed to do so.

Fed­eral Re­serve Chair­man Ben S. Bernanke said in a June 7 speech that the Fed re­mains on track to with­draw from the Trea­sury mar­ket, stress­ing that the cen­tral bank must re­main vig­i­lant against in­fla­tion at the same time it tries to nur­ture the econ­omy back to healthy growth.

Not an easy task

The end of the Fed’s pro­gram would never be easy given the huge on­slaught of sched­uled Trea­sury bor­row­ing, but the task will be more dif­fi­cult be­cause for­eign in­vestors in the past six months have been re­duc­ing their siz­able hold­ings of U.S. debt, not in­creas­ing them.

That means to get those buy­ers back, the Trea­sury may have to raise the rates it pays on the debt.

“With the Fed pretty much out of the pic­ture af­ter June, it seems clear that for­eign de­mand for Trea­suries holds the key go­ing for­ward,” said David Green­law, an an­a­lyst at Mor­gan Stan­ley. “Con­tin­ued heavy buy­ing by the largest for­eign hold­ers of Trea­suries will prob­a­bly be nec­es­sary” to pre­vent in­ter­est rates from ris­ing, he said.

China and Ja­pan re­main the largest for­eign buy­ers of Trea­sury debt, fol­lowed by oil ex-

China and Ja­pan re­main the largest for­eign buy­ers of Trea­sury debt, fol­lowed by oil ex­porters such as Saudi Ara­bia and Qatar. Even oil ex­porters that are hos­tile to the U.S. such as Iran and Venezuela have been among the buy­ers sup­port­ing the Trea­sury in the past, ac­cord­ing to Mor­gan Stan­ley es­ti­mates.

porters such as Saudi Ara­bia and Qatar. Even oil ex­porters that are hos­tile to the U.S. such as Iran and Venezuela have been among the buy­ers sup­port­ing the Trea­sury in the past, ac­cord­ing to Mor­gan Stan­ley es­ti­mates.

China and many of the oil ex­porters of­ten chan­nel their in­vest­ments through Lon­don and such off­shore in­vest­ment havens as the Chan­nel Is­lands, so the ori­gin of the fund­ing is some­times dif­fi­cult to track. The un­cer­tainty of where the money is com­ing from in it­self will cause rates to rise and in­crease volatil- ity in the Trea­sury mar­ket af­ter the Fed ex­its, Mr. Green­law said.

Brazil, Tai­wan and Rus­sia also are among the Trea­sury’s ma­jor cred­i­tors. But many coun­tries have been cut­ting back on their pur­chases of U.S. se­cu­ri­ties in the past six months out of concern about the rapid de­cline of the U.S. dol­lar and ris­ing in­fla­tion, which hurts their in­vest­ment val­ues.

Vas­sil­lli Sere­bri­akov, an an­a­lyst at Wells Fargo, said many for­eign­ers were put off by the Fed’s bond-pur­chase pro­gram, which ap­peared to trig­ger a for­eign sell­off of about $100 bil­lion in Trea­sury hold­ings since last fall.

Still, given the wari­ness over­seas about the Fed’s poli­cies and un­tamed fed­eral deficits, go­ing back to re­ly­ing on for­eign buy­ers to fi­nance the large ma­jor­ity of the debt could be tricky, he said.

“The key ques­tion is to what ex­tent one can ex­pect the re­cent de­te­ri­o­ra­tion in the long-term cap­i­tal flows to be re­versed,” he said.

An un­de­ter­mined fu­ture

For­eign in­vestors have ap- plauded the Fed’s de­ci­sion to end the pro­gram as it im­proves the prospects for keep­ing a lid on in­fla­tion. But they will con­tinue to be con­cerned about un­con­trolled deficits and de­clines in the dol­lar that di­min­ish the value of their in­vest­ments, he said.

“Some of the re­duc­tion in Fed Trea­sury pur­chases could be re­placed by in­creased de­mand from for­eign in­vestors, but this chan­nel is less cer­tain,” he said.

Peter Schiff, pres­i­dent of Euro Pa­cific Cap­i­tal, said he does not ex­pect enough for­eign or pri­vate buy­ers to step for­ward and pur­chase Trea­sury’s huge slate of debt of­fer­ings, a po­ten­tially cat­a­strophic de­vel­op­ment that he thinks will force the Fed to backpedal and re­new its bond-buy­ing pro­gram.

“Do they ex­pect the Chinese to re­verse course on their cur­rent pol­icy and start heav­ily buy­ing U.S. debt once again?” he asked.

“That seems ex­tremely un­likely given” that China has been in­vest­ing less in Trea­sury bonds partly in re­sponse to de- mands from the United States that it stop skew­ing trade re­la­tions be­tween the coun­tries by hoard­ing huge sur­pluses of dol­lars it earned through trade and rein­vest­ing them in Trea­suries.

Mr. Schiff noted that Bill Gross, the head of Amer­ica’s own Pimco bond fund, the largest buyer of bonds world­wide, re­cently re­duced Pimco’s hold­ings of Trea­suries to zero out of concern that they weren’t yield­ing enough given the risks of in­fla­tion and deficit spend­ing.

“It is not clear what would con­vince Gross to get back into the mar­ket with both feet, but one might ex­pect at min­i­mum it would take much higher in­ter­est rates,” Mr. Schiff said.

Jef­frey Klein­top, chief mar­ket strate­gist at LPL Fi­nan­cial, said he is not wor­ried about the Trea­sury find­ing buy­ers or about other mar­ket dis­rup­tions as the Fed pulls back.

“While in­ter­est rates are likely to rise mod­estly, we do not an­tic­i­pate a spike re­sult­ing from the lack of Fed buy­ing that would put the econ­omy at risk,” he said.

A fail­ure by Congress and the White House in com­ing weeks to agree on a plan to curb deficits would be a much big­ger prob­lem for the mar­kets, Mr. Klein­top said.

“The bud­get and debt-ceil­ing de­bate may be of more im­por­tance since fis­cal pol­icy could tighten sharply or a fail­ure to con­trol the deficit could spike in­ter­est rates, in ei­ther case putting the econ­omy at risk,” he said.

ASSOCIATED PRESS

“Do they ex­pect the Chinese to re­verse course on their cur­rent pol­icy and start heav­ily buy­ing U.S. debt once again?” asked Peter Schiff, pres­i­dent of Euro Pa­cific Cap­i­tal. “That seems ex­tremely un­likely given” that China has been in­vest­ing less in Trea­sur y bonds partly in re­sponse to de­mands from the United States that it stop skew­ing trade re­la­tions be­tween the coun­tries by hoard­ing huge sur­pluses of dol­lars it earned through trade and rein­vest­ing them in Trea­sur ys.

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